Hermes has engaged with Suzano, a leading Brazilian pulp and paper company, on ESG-related matters since 2014 and we have seen significant improvements in disclosures of environmental information.
Our engagement was focused on environmental issues, specifically the disclosure on industrial processes and chemicals used in them. Progress has been made and Hermes’ recommendations were included in the company’s sustainability reports from 2015 onwards, with disclosure coming in line with its peers. Notably, in its sustainability report, Suzano states that it does not use elemental chlorine in its bleaching process. Hermes has also engaged with Suzano on the use and development of GMO trees.
With regards to governance, Hermes is also engaged on board composition and evaluation and remuneration disclosure. Corporate governance has improved and this has been further precipitated by the shift from a dual share class to a single share class and the listing on the Novo Mercado in 2017, a Brazilian listing segment for companies that voluntarily adopt additional corporate governance practices beyond those required by Brazilian legislation. These governance improvements and single share class enabled Suzano to successfully acquire Fibria, its second biggest competitor in the Brazilian market. This acquisition has enhanced the group’s business profile and coincided with credit ratings upgrades and spread outperformance.
Third party ESG research providers can penalise issuers such as Suzano due to issues such as GMO development. However, we feel this is partially balanced by responsible development practices, with GMO trees not being used on a commercial level. Moreover, they have higher productivity per land area and could provide a solution for lower water usage, meaning that these trees are potentially less resource intensive.
Suzano also has certifications from the Forest Stewardship Council (FSC) – but as this doesn’t cover GMO trees, Suzano is cautiously managing its GMO programme so as not to put its FSC certification at risk.
China’s real-estate companies have exhibited a period of high growth over the past decade, with rapidly growing enterprise valuations and increasingly larger, and often complex, capital structures.
The cost of debt issuance is relatively high for many of the market leaders in the sector. Corporate issuers are seeking to minimise their cost of financing, from improving their financial ingenuity to broadening the geographical base of their investors.
Homebuilders play a crucial role in driving urbanisation and economic growth in China. New housing stock has improved standards of water sanitation and internet penetration. Urban town planning allows for closer proximity to workplaces and community amenities.
Furthermore, land sales to developers and property sales to homebuyers form a significant contribution to local-government tax revenues.
ESG opportunities for investors
We see substantial unaddressed ESG risks in the sector, associated with the rapid deployment of new urban properties across the Chinese republic.
There is therefore the potential to apply our engagement approach to the management teams of these companies in a bid to reach our common goal of reducing credit risk.
We recently initiated dialogue with two Chinese homebuilders separately, with a plan of engagement focused on addressing three key factors.
The first was human capital management relating to the health and safety of construction workers, and the second was the quality and suitability of construction completed.
Finally, we engaged on issues relating to financing arrangements.
Using engagement to respond to a real-world incident
One of the companies had pressing targets set for the completion of a property build within a three-to-four month time frame, from land acquisition to delivery.
Unfortunately, the pressures resulted in major accidents at the site last year.
In addition to our concerns on a human level, we argued that repeated incidents would lead to margin erosion, free cash-flow detriment and reduced confidence in the company’s non-Asian investor base.
The company responded by sharing new measures with us to minimise a repeat of the incidents.
These included extending the sale-to-completion target, introducing back-loaded fees to be paid on completion of construction and changes to personnel remuneration schemes to incentivise safe delivery over property completion.
The company also strengthened safety clauses in supplier contracts and established a health and safety committee at the project, district and company level to monitor construction in progress.
Transparency is key
At Hermes, we strongly believe that transparency is key to improving ESG results in practice.
We therefore also encouraged the company involved in this engagement to make regular public disclosures in relation to each of these new implemented changes.
This has helped to restore investor confidence and assist investors in analysing the company’s improvement in ESG-related practices and behaviours.
In the case of one of the companies, we sought to understand capital-allocation policies and aspirations for the funding of green projects.
We also probed the financial discipline and rationale behind the adoption of a subsidiary structure for a new bond issuance – a decision that had caused concerns amongst investors.
We are now having ongoing discussions with the company amid the adoption of a new structure to segregate onshore and offshore funds, off-balance sheet financing and the issuance of green financing committed to green buildings, to be in line with the government policies and incentives.